IDEAS home Printed from https://ideas.repec.org/p/fip/fedlwp/2019-007.html
   My bibliography  Save this paper

Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences

Author

Listed:
  • YiLi Chien
  • Yi Wen

Abstract

We build a tractable heterogeneous-agent incomplete-markets model with quasi-linear preferences to address a set of long-standing issues in the optimal Ramsey taxation literature. The tractability of our model enables us to analytically prove the existence of a Ramsey steady state and establish several novel results: (i) In the absence of any redistributional effects of capital taxation or lump-sum transfers, the optimal capital tax is exclusively zero in a Ramsey steady state regardless of the modified golden rule (MGR) and government debt limits. (ii) Whether the MGR holds or not depends critically on the government's capacity to issue debt but has no bearing on the planner's long-run capital tax scheme. (iii) The optimal debt-to-GDP ratio, however, is determined by a positive wedge times the MGR saving rate: The wedge is decreasing in the strength of individuals' self-insurance positions and approaches zero when the idiosyncratic risk vanishes or markets are complete. (iv) The assumption of the existence of a Ramsey steady state commonly made in the existing literature is not innocuous: When a Ramsey steady state does not exist but is erroneously assumed to exist, the MGR always appears to “hold" and the implied “optimal" long-run capital tax is strictly positive. (v) Along the transition path toward a Ramsey steady state, the optimal capital tax depends positively on the elasticity of intertemporal substitution. The key insight behind our results is that in the absence of any redistributional effects, taxing capital in the steady state permanently hinders individuals' self-insurance positions and thus the Ramsey planner opts to issue debt rather than impose a steady-state capital tax to correct the capital-overaccumulation problem. However, if the demand for debt approaches infinity when the interest rate approaches the time discount rate, a Ramsey steady state may not exist; thus, the MGR can fail to hold in a Ramsey equilibrium whenever the government encounters a binding debt limit.

Suggested Citation

  • YiLi Chien & Yi Wen, 2019. "Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences," Working Papers 2019-007, Federal Reserve Bank of St. Louis, revised 18 May 2020.
  • Handle: RePEc:fip:fedlwp:2019-007
    DOI: 10.20955/wp.2019.007
    Note: Revision of WP 2017-024, Optimal Ramsey Capital Income Taxation—A Reappraisal https://doi.org/10.20955/wp.2017.024
    as

    Download full text from publisher

    File URL: https://s3.amazonaws.com/real.stlouisfed.org/wp/2019/2019-007.pdf
    File Function: Full Text
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. François Le Grand & Xavier Ragot, 2017. "Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks," Sciences Po Economics Discussion Papers 2017-03, Sciences Po Departement of Economics.
    2. Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-1175, December.
    3. Julio Dávila & Jay H. Hong & Per Krusell & José‐Víctor Ríos‐Rull, 2012. "Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks," Econometrica, Econometric Society, vol. 80(6), pages 2431-2467, November.
    4. Sebastian Dyrda & Marcelo Pedroni, 2015. "Optimal Fiscal Policy in a Model with Uninsurable Idiosyncratic Shocks," Working Papers tecipa-550, University of Toronto, Department of Economics.
    5. Yili Chien & Harold Cole & Hanno Lustig, 2011. "A Multiplier Approach to Understanding the Macro Implications of Household Finance," Review of Economic Studies, Oxford University Press, vol. 78(1), pages 199-234.
    6. Emmanuel Farhi, 2010. "Capital Taxation and Ownership When Markets Are Incomplete," Journal of Political Economy, University of Chicago Press, vol. 118(5), pages 908-948.
    7. Nakajima, Tomoyuki, 2005. "A business cycle model with variable capacity utilization and demand disturbances," European Economic Review, Elsevier, vol. 49(5), pages 1331-1360, July.
    8. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
    9. Ljungqvist, Lars & Sargent, Thomas J., 2012. "Recursive Macroeconomic Theory, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262018748.
    Full references (including those not matched with items on IDEAS)

    Citations

    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences
      by Christian Zimmermann in NEP-DGE blog on 2019-03-21 16:04:46

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Odran Bonnet & Guillaume Chapelle & Alain Trannoy & Etienne Wasmer, 2019. "Secular Trends in Wealth and Heterogeneous Capital: Land is Back... and Should Be Taxed," Sciences Po Economics Discussion Papers 2019-14, Sciences Po Departement of Economics.

    More about this item

    Keywords

    Optimal Capital Taxation; Ramsey Problem; Incomplete Markets;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedlwp:2019-007. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (). General contact details of provider: http://edirc.repec.org/data/frbslus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.